Innovative Ideas, Innovative Web

Revenue Maximization and Profit Tax

For revenue maximising managers subject to a target rate of profit constraint, a profit tax will result in reduced output and higher prices. Fig. 10.5 shows profit at each rate of output. Let II represent a target return set by management. Suppose this is the minimum profit acceptable to the owners of the firm. Note, however, that profit is less than II at Q1. Thus managers must act to increase profit at least the target rate of return. Suppose the objective of managers is to maximise revenue subject to the constraint that their firm earn at least its target rate of profit. Output rate Q2 in Fig. 10.5 is the quantity that meets this objective. Any output greater than Q2 yields less than the target rate of profit. Because MR is positive at output rates less than Q2 that generate reduced TR. Corresponding to the output rate Q2 is the price P2‘

Now suppose that a proportional profit tax is imposed. Fig. 10.5 shows that after-tax profit at Q2 is now less than II. Thus, to maximise revenue while satisfying the target profit constraint, output must be reduced to Q3 and the price increased to P3·